Henry Cobbe – Default fund transparency at last?

Default evaluation has historically focused on the performance of funds inside the strategy rather than the strategy itself. It is time this changed says BirthStar managing director Henry Cobbe

One of the criticisms often levelled at the DC pensions industry is that it has been too opaque.  But thankfully, there are improvements.  Transparency initiatives on fees, reporting and oversight, driven by the DWP and worked through by a joined-up FCA/TPR approach are now beginning to take effect. Against the backdrop of structural change in the industry, this is progress indeed.

One area that has been harder to resolve is around investment governance.  TPR puts Good Member Outcomes (‘GMO’) and Value For Money (‘VFM’) at the heart of scheme quality. With these in mind, TPR has clearly articulated what investment governance should look like.  Steps include, amongst other things, clear guidelines for the selection and removal of investment managers, benchmarks for investment options, due consideration of risk and return, net of fees, in the design of the default strategy, assessments of the performance of each investment option and the ability to remove under-performing investment options if appropriate.  All of which should be reviewed regularly and at least every three years.

But while the processes and responsibilities are clear, the analytical toolkit to inform this investment governance is only now emerging.

While forward looking scenario modelling is commonplace, and subject to its own modelling constraints, there has been no way of evaluating historic performance of different default strategies as experienced by different cohorts of savers.  To date performance evaluation has focused on the performance of funds inside a default strategy rather than the strategy or ‘glidepath’ as a whole.

This is inadequate because, for example, the same cohort invested in the same funds on different glidepaths. For example one lifestyling over 5 years and another over 15 years will experience very different performance outcomes for the same sequence of returns in a given time period.

Similarly, different cohorts, for example one cohort expected to retire in 2015, and another in 2025, invested in the same funds on the same glidepath will experience very different performance outcomes for the same sequence of returns in a given time period.

Obviously, the outcomes will be different again with the same funds, depending on the glidepath and/or the cohort, for a different sequence of returns in a different time period.

Hence the need for a consistent, methodical and repeatable approach for evaluating glidepath performance.

Value For Money shouldn’t be about price. It should be about value. And measuring that requires a definition. We suggest that an appropriate measure would be “risk-adjusted absolute and relative performance net of fees for discrete cohorts of savers”.  This enables evaluation both of the strategic glidepath relative to a broad reference benchmark and also the actual implementation of the strategy relative to its own strategic glidepath. This measures the added (or subtracted) Value For Money of the default strategy from both design and implementation.

Through our research arm Elston Consulting we have been closely involved with, and have an interest in, the development of the FTSE UK DC Benchmarks since co-hosting with FTSE last year two workshops with representatives from DWP, TPR, FCA, ABI, Association of Pension Lawyers, IMA, CFA Society of the UK, PPI, NAPF, professional trustees, asset managers and consultants.

Our position was that the status quo of opacity around default strategy performance evaluation was unacceptable, and the new standard and custom benchmarks will enable a much needed evaluation framework where none formerly existed.

The launch in October of the FTSE UK DC Benchmarks will enable GMO and VFM evaluation.  The standard range provides a broad reference benchmark, the custom range provides a custom benchmark for any given DC default strategy whether designed by a master trust, GPP provider, asset manager or consultant; and whether delivered using lifestyling or using target date funds.  It provides a consistent framework to convert a glidepath into consistent data, to inform meaningful comparison.

This means that, possibly for the first time, trustees, providers, independent governance committees, consultants, advisers and employers can having meaningful discussions about all of the major determinants of investment outcomes by cohort: contribution rates, expected outcomes (net of fees), and, finally, the actual net risk-adjusted performance of the default strategy as a whole.   This brings a quantifiable focus on Value For Money and Good Member Outcomes between advisers and their corporate clients to promote transparency and enable good governance.